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George is blowing a bubble, and no this is not a reference to the royal baby, rather to the right royal mess George Osborne may be creating with his Help to Buy scheme. The list of those accusing our chancellor of creating a new housing bubble is getting longer. But then our George says he is just trying to create a construction boom, and if he can do that, this will surely be a good thing. So which one is it: construction boom or housing bubble?

Help to Buy comes in many guises. New Buy, was a scheme aimed at first time buyers and provided assistance solely if they bought a new home. So the idea behind the scheme was actually quite laudable. But the latest iteration is not like that. This is destined to help people who can only rustle up say a 5 per cent mortgage.

Home builders say that the latest idea will encourage them to build more, but then, frankly they would say that wouldn’t they? What house builders really want, what they really really want is for house prices to go up in value enabling them to build and sell homes for a very substantial profit on land which they have already paid for.

This week credit ratings agency Fitch stated: “The scheme, [that’s Help to Buy] along with the phase that began in April [New Buy] could have an impact on sovereign gross debt and its dynamics, particularly if there is strong pent-up demand as the tighter loan-to-value ratios that have prevailed since 2008 are relaxed.” It continued: “For house builders the main benefit from the second phase of the scheme will come from rising house prices, rather than increased volumes.”

A couple of weeks ago Vince Cable warned that a housing bubble was a danger, and the IMF made similar warnings before that.

Oh why, oh why won’t George listen?

It is just that according to a housing construction survey from the Royal Institution of Chartered Surveyors (RICS): “59 per cent more respondents predicting workloads continuing to rise rather than fall once more.” According to recent data from the ONS, construction activity grew by 0.9 per cent in Q2. The latest Purchasing Managers’ Index from Markit/CIPS for construction rose to its highest level since June 2010.

This is good stuff. Apparently, or so says RICS, every pound spent on construction leads to £3 more economic growth, so that is a good thing. On the other hand, to put the construction boom in perspective: in Q1 2013 construction output was at its lowest level since Q1 2001.

Is George blowing bubbles or creating a construction boom? The most likely consequence is that this is doing both, and that is both good and bad.

It is a little odd. The UK enters its worst downturn ever recorded; average wages increase at a rate that is much slower than inflation meaning that for some time average households have been getting worse off, but what do house prices do? Sure they crashed in the US; they crashed across much of Europe – especially in the troubled parts of the region – they crashed in the UK once too, but that was back in the 1990s.

But this time around, prices fell – a bit – but right now, and without doubt, they appear to be on an upwards trajectory. Some say there are similarities between the UK economy over the last few years and Japan 20 years ago. There is one glaring difference, however. In Japan house prices crashed and went on crashing. In the UK, the story has been quite different. So why is that? And can we expect a happy ending for the UK housing market?

Now Vince Cable has joined the ranks of those who fear that the government may be creating a housing bubble. He was interviewed on the ‘Andrew Marr Show’ yesterday, and said: “I am worried of the danger of getting into another housing bubble.” But frankly the warnings have been coming from every quarter and indeed from every quintile or even decagonal.
There is more than one side to this debate. What the UK needs is more construction, and more new houses.

One figure being bandied about at the moment is that every pound spent on construction stimulates the economy by £3. A residential construction boom needs mortgages to be made available. The danger is that mortgage supply will rise, demand for housing will increase but supply won’t. If that were to happen we might get higher house prices, but it is questionable whether UK plc will be better off.

In fairness to the chancellor he is trying. When he recently unveiled his latest initiative for his Help to Buy Scheme, he invited house builders along to hear his announcement first hand. And there are signs of a pick-up in construction. After falling to its lowest level since 2001 in the first quarter of this year UK construction activity rose 0.9 per cent in Q2, according to the ONS.
A rough rule of thumb might go like this: a buoyant mortgage market leading to more construction is good, but one leading to higher prices but not more construction is bad.

Yet the UK media seem obsessed with the idea that rising house prices is a good thing. If we get the slightest hint that house prices are set to rise, certain newspapers splash it all over their front cover. In recent days we have seen the media say over and again: the weather is hot, Britain is winning in sport and house prices are going up!

But why is it really seen as a good thing when house prices rise? Why are the UK public so convinced house prices can only ever rise? One argument to justify the argument that house prices can only ever rise in the UK is that the UK is an island and land is in limited supply. If that is so, how is it that house prices have fallen in Japan, which you may have noticed is also an island based economy?

Ex MPC man – a man famous for his ultra-dove-like view on monetary policy, a man who continuously voted for more QE, and indeed called for QE being used far more imaginatively – Adam Posen penned a piece for the ‘FT’ this weekend and he made a good case. In an article headlined “The cult of home ownership is dangerous and damaging”, Mr Posen said: “There is no iron law that higher-income economies must have higher rates of home ownership: Mexico,

Nepal and Russia all have home-ownership rates of more than 80 per cent, while the French, German and Japanese rates are 30-40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 per cent.”

Mr Posen’s main point is that because in the UK our home is our main financial asset, he said: “We incentivise middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset.”

There is one point about the housing market which gets overlooked. Sure housing has proven to be good investment over the last few decades, but the reason for this is not because house prices keep going up, it is because housing investment is just about the only form of investment available to the mass market that employs leverage.

You borrow 75 per cent of the value of a property, and the property doubles in value, your equity increases fivefold. Leverage is also available to private equity companies, which is why they enjoyed a boom during the noughties, but leverage of investment trusts was one of the factors behind the stock market boom that led to the 1929 crash. Leverage is appealing but it is also dangerous.

But here is a theory – just a theory – as to why the Brits so love the idea of house prices as an investment.

The Brits have bought into a story. It was a story that had its roots in the 1960s and 1970s. At the beginning of this period, house prices to income were quite cheap. Over the following two decades four things happened. Firstly, as mortgages became more widely available, house prices to income rose. Secondly, as productivity grew, real wages rose. Thirdly, inflation meant nominal incomes rose very sharply. Fourthly, for much of this period, real interest rates were negative, that is to say the percentage rate of interest was less than the percentage rate of inflation. These four factors, when combined with the magic of leverage, made buying a house an incredibly lucrative thing to do.

During this period the idea was born that when you enter the housing market the best thing to do was buy the most expensive property you could. This period also saw the birth of a new metaphor, ‘the housing ladder’. The story that emerged during this period is so strong that people still think its lesson applies today.

But is that right? House prices are no longer cheap relative to incomes. Real incomes have not been rising for some time. Nominal wages have been rising only very slowly. Sure, real interest rates are negative again. But what will happen when the baby boomers retire, and many of them try to downsize, using the spare equity in their homes? What will happen if real interest rates rise, because of actions beyond the control of the Bank of England? See: The Great Reset

The narrative of the UK housing market suggests that house prices always go up. But many of the facts that created that narrative have changed.

When pieces of the narrative are changed at a later date, the overall initial impression is unaltered. The narrative changes us, and retrospective changes to the narrative don’t reverse the original effect it had on us. If we were to find out years after we first heard the story that that actually Cinderella, was a manipulative little so and so, we would probably still think she had an evil step mother and sisters.

Until that is the narrative is proven to be wrong beyond any doubt. But by then, it may be too late to do anything about it.

Vince Cable has a cunning plan to kick life into the UK economy. It is called a British Business Bank. “We need bold action to fix what has always been a weakness of the UK economy,” he said last week, but there is a question mark. Is Vince’s plan bold enough?

David Petrie, head of corporate finance for the Institute of Chartered Accountants in England and Wales, has doubts. “It is shaping up to be a missed opportunity to make a real difference, especially to micro and smaller businesses,” he has said. So what’s wrong?

First of all, he reckons small businesses are being side lined. Secondly, he is worried that the business bank will not work directly with businesses, but will be one step removed.

Thirdly, he says the money being talked about is nowhere near enough. He reckons the bank will need a minimum of £10 billion of capital.

And fourthly, he says the plans unveiled by Vince Cable amount to little more than a respray of the old Capital for Enterprise scheme.

Mr Petrie’s observations are worrying, but – sadly – probably about right. It is a sort of puzzle. The UK government throws billions at mortgages, the Bank of England prints £375 billion to buy government bonds under its quantitative easing programme, and Vince’s new business bank will have £1 billion of new money.

He says the UK needs bold action, but what we get is timid packaging and the re-jigging of old initiatives that didn’t do much the first time around. Banks have not been failing business for the last few years; they have been failing UK businesses for a decade or longer. For way too long it has much easier to get a mortgage, or even a loan to pay for a holiday than to get funding for a business.

Back in November 2008, Edmund Phelps, a former winner of the Nobel Memorial Prize in Economics, said in an interview with ‘Spiegel Online’: “A fundamental issue that regulatory discussions must confront… is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some [of] their credit to the business sector.”

But the problem runs deeper than banks. It lies deep within the British and indeed European psyche.
In his book ‘Them and Us’, Will Hutton says: “The European Flash Barometer found that around 43 per cent of people in the UK (compared with 19 per cent in the US) believe that a new business should not be created if there is a risk it may fail.”

The more potentially innovative a business is, the more the chances are it will fail. Bank lending to innovative business does not make sense, because the probability that the business may fail is too high. It only makes sense to back an innovative business if the provider of capital has shares in the upside if things go well – that is to say a share in profits. That way, the successful funding deals can make up for the ones that don’t work. This is the issue a business bank needs to grasp.

In 2008 UK average labour costs per hour, measured in euros were 20.9. In 2012 they were 21.6 euros. That’s a rise of just 3.3 per cent.

Or let’s use sterling rather than euros as the measure. In 2008 unit labour costs per hour were £16.70.In 2012 they were £17.50, which is a growth rate of 5.2 per cent. Contrast that with Germany where unit labour costs are up 9.1 per cent. They are much higher too: 30.4 euros in 2012.

In France, unit labour costs have risen 9.5 per cent to 34.2 euros. Of course, Germany has roughly half the unemployment rate of France.

The highest unit labour costs are in Sweden: 39 euros, while Denmark, Luxemburg, Finland, Belgium, the Netherlands, and Austria all have unit labour costs over 30 euros an hour.

Of the 27 counties in the EU, 15 have lower unit labour costs than the UK. They are slightly lower in Cyprus, a lot lower in Greece (14.9 euros), much higher in Ireland (29 euros), lower by the tiniest of margins in Spain, and significantly higher in Italy (27.4 euros).

In terms of growth between 2008 and 2012, only Ireland, Greece, Latvia, Lithuania, Hungary, Poland and Portugal saw a lower growth rate.

Unit labour costs contracted in Lithuania, Hungary, Poland and –most notably – in Greece, where they have fallen 11.2 per cent.

From an economic point of view, falling unit costs are good in the sense that they provide a country with improved competitiveness. But they are bad in the sense that they are a function of productivity, and wages. That Greek wages are falling so fast may be an indication that the country is gradually becoming more competitive but the resulting depression is really rather nasty.

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This is no wind up. The last week or so has seen hints. The green shoots may not be big, peeking above the surface like scared mice, but they have been there all the same. So is this for real? Has the recovery begun?

Yesterday on the Andrew Marr Show former Prime Minister John Major said: “Recovery begins from the darkest moment. I’m not certain, but I think we have passed the darkest moment.”

So what’s the evidence?

Earlier this month, data from the ONS revealed another rise in employment – this time up 236,000 in the three months to July. Elsewhere, data on July’s industrial production indicated the biggest jump in this sector for 25 years. The OECD took a look at the G7 and the four big emerging economies (BRICs) and saved its most bullish words for the UK and Brazil, which were the only countries that it said were due to see a pick-up next year.

The round of good news was completed by the Centre of Economics and Business Research (CEBR), which has forecast that 2013 will see the first rise in real incomes for UK households since 2009.

Looking beyond the UK’s borders, markets were c*ck-a-whoop. Both the US Fed and the Euro regions’ central bank – the ECB – have announced QE (or in the case of the ECB QE ish), and at last they are saying central bankers are taking decisive action. A report from ‘Financial Times Deutschland’ suggested that unit labour costs have fallen by 15 per cent in Greece since 2010, with significant falls also seen in Spain and Ireland. Greece saw its current account deficit fall by 54 per cent between 2007 and 2011.

Finally maybe policy makers are learning lessons. Vince Cable is agreeing to relax labour laws in the UK. David Cameron wants to cut down on red tape, and make it easier to gain planning permission. He wants to see an end to dithering.

Then there is the funding for lending scheme. This is an idea that really seems to have struck a chord across the world, so much so that some economists in the US are now urging the Fed to announce a similar idea.

And finally, the World Economic Forum has released its latest league table showing the world’s most competitive countries. And guess which country moved from number ten on the chart to number eight? Yes, that’s right the UK. The usual suspects did better: Switzerland, Singapore, Finland, Sweden and the Netherlands. But of the G7 only Germany in sixth spot and the US in seventh scored higher.

Recessions are bad, of course they are, but they can have a cleansing effect. They can correct bad habits, get rid of bad ideas, and create economies that are more focused on ideas that work. The UK has had a torrid few years, but maybe it is now set to benefit from the correction.